As you might expect from someone whose unremittingly downbeat expectations for markets have won him the nickname ‘Dr Doom’, Societe Generale’s highly regarded global strategist Albert Edwards is not given to very many moments of levity.
A recent note, however, found him reminiscing about the following chart, which a few years back he had christened ‘Le Poisson’ because, well, it resembles a fish.
Le Poisson: UK pension fund equity and debt allocation (%)
Red line: Equity Black line: Bonds
Source: Datastream. Taken from Societe General, Global Strategy Weekly, 6 July, 2017.
The chart, which illustrates the decline in equity exposure – and concurrent rise in bond exposure – in UK pension funds over the two decades to 2010 – led us to reflect on a couple of points, here on The Value Perspective.
First, it really does look like a fish and, second – and rather more importantly – in recent years, the two lines will have completed its nose and then kept on going.
So what is happening here – and why?
As growth expectations for equities have moderated throughout this century, pension funds’ equity exposure has fallen.
For their part, bonds have seen their yields fall over the past 30 years – particularly so over the past 10 – and exposure to the asset class has risen.
Whenever the two lines cross, it tends not to be an auspicious time for investors – as those who were around during the market crash of the mid-1970s will remember.
Nobody can say for sure what will happen – though time, as it always does, will tell. Here on The Value Perspective, however, we see two very obvious reasons behind the current state of affairs.
The first reason
The first – and please do bear with us – relates to accounting and the fact pension funds are encouraged to match their assets (the contents of their portfolios) with their liabilities (the pensions they must eventually pay out to members).
Since a key driver of the latter – UK government yields – is also a key driver of all UK bonds, the theory runs that an increased holding in fixed income assets will help to reduce the risk of a portfolio (or at least its volatility, which is not quite the same thing).
Of course, for the theory to work, all else must remain equal and all else is rarely so obliging – but, still, this is now seen as good accounting practice.
An alternative view (indeed, the ‘outside view’ we have discussed in articles such as Even Sir Ben Ainslie) is this approach is effectively trying to match a real liability – that is, a requirement to meet people’s income over a very long period of time – by buying an asset that has almost no ability to adjust for changing economic circumstances and is especially vulnerable to inflation.
More worrying still, this approach is effectively trying to match a real liability by buying into an asset class that is at the most expensive levels it has ever been in its history.
That has echoes of the late 1990s when many investors thought they were ‘de-risking’ their portfolios by increasing their allocation to technology stocks in line with their growing weight in benchmark indices – a decision that ended very badly indeed.
The second reason
The second reason for the current state of affairs is sheer momentum.
To add another aquatic metaphor into the mix alongside the fish-like graph, investors are guilty here of the behavioural finance sin of ‘anchoring’ – that is, they are basing their perceptions on the current environment rather than recognising that something entirely different could happen in the future.
Here they are assuming that – in spite of their being way higher than their 100-year average – the extremely consistent, low-volatile and largely excellent returns produced by bonds over the last 10 or 15 years will continue to be enjoyed indefinitely.
After all, why would that ever change?
Aside, of course, from the fact it always does. To us, believing otherwise smells every bit as fishy as the above graph looks.